The EU VAT Forum has made a first evaluation of the VAT cross border rulings pilot case. National tax authorities and businesses favour extending the initiative to other EU Member States. For further information see the information note and the interim report containing a first list of cross-border rulings.

Translations of the report will be available in the 2nd half of August.

The European Commission has announced that the EU VAT Forum extended the test case for another year. The pilot project has also been opened to other Member States than the ones already participating. For further information see the press notice.

June 2013 – December 2014 – Cross border VAT Rulings test case in 15 Member States

See the description in the 14 languages of the participating Member States.Within the framework of the EU VAT Forum, 15 EU Member States have agreed to participate in a test case for private VAT ruling requests relating to cross-border situations.

Taxable persons planning cross-border transactions between two or more of these participating Member States Belgium, Estonia, Spain, France, Cyprus, Lithuania, Latvia, Malta, Hungary, Netherlands, Portugal, Slovenia, Finland, Sweden and the United Kingdom can ask for such a ruling with regard to the transactions they envisage.More detailed information regarding the conditions and procedure can be found in the information notice. The test case started on 1 June 2013 and is scheduled to last till the end of 2014.

Membership

The following organisations representing business, have been appointed for a three year mandate starting on 1 October 2012.

Statistical sampling has the added benefit of allowing the determination of the exact amount of any tax assessment by the tax authorities.

In our working method, we use the same method as the Dutch tax authorities. A “pre-audit” statistical sampling performed ‘internally’ offers insight into the tax risks that an enterprise encounters with respect to indirect taxes. Furthermore, for the tax department, this is an efficient and effective way to test the effectiveness of its Tax Control Framework.

The result could be used to get indirect taxes higher on the priority list, since managing of material risk that are quantified falls within the KPIs of a CFO.

VAT decisions are more and more shifting from employees who make entries in the system manually to ultimately the ERP system based on implementation of conditions tables/defaults. Data analysis can be a way of testing whether these VAT decisions are logical. Such analyses can include all the transactions in a selected period (year, quarter, month).

The results of the data analysis can provide insight into the existing compliance risks or opportunities with respect to the remittance of too much or too little VAT.

In a SAP review we verify the proper working of the implemented VAT configuration. Changes in the business model, master data or legislation will have an impact on the implemented VAT configuration.

The SAP review can demonstrate that the VAT configuration must be improved or that additional control measures should be added to the Tax Control Framework. The review can also bring errors and risks to light, allowing a more focused data analysis to take place.

After the quantification and evaluation of the risks and errors, these are assigned a risk profile in order to be able to test against risk tolerance.

The KEY Group has extensive expertise in the area of Business Controls / Internal Controls and has developed a normative framework for indirect taxes: a VAT Control Framework.

The actual situation (IST position) within the organization is then measured against this yardstick, generally resulting in a summary of the differences. Analysis of these gaps and the associated risks may lead to acceptance or to proposals for improvement.

It is an efficient and effective approach to test a company’s VAT Control Framework and to challenge the responsible process owners.

There is a new legal requirement for the creation and submission of an electronic tax balance sheet (e-balance) in XBRL for all companies located in Germany. This poses a major challenge because many ERP software providers, such as SAP, do not offer a satisfactory solution for complying with the comprehensive legal requirements. Separate software applications for the submission of the report will be required.

The new requirement relates to the monthly submission of the so-called SAF-T reports for Portugal, which is mandatory since 1-1-2013. It is possible to use standard SAP for creating the required report but it is a very complicated change in SAP (more than 100 OSS notes) that will consume a lot of IT resources.

We are currently developing an easy-to-use and lean SAF-T cockpit solution integrated in SAP with country specific flexibility. The KEY LiNKiT SAF-T solution is built in SAP and will be able to generate automatically based on the specific country’s legal requirements (e.g. every month and output) the mandatory SAF T files that need to be reported to the tax authorities.

Cash flow planning (test phase)

Cash flow planning – Integrated in SAP a cockpit for cash flow planning by which the current ‘as is’ can be compared with ‘as if/what if’ for optimum and effective planning and monitoring.

In addition to evaluating tax risks (level of tolerance), companies should also determine and manage their reputational risks as part of tax risk management.

It is important, as governments and tax authorities consider the combat a high priority and has introduced anti-abuse legislation, have increased tax audits and uses tax litigation at its full potential with publishing the outcome when tax evasion is in play.

Nasir Khan had a successful accessories business, a jet-set lifestyle and reputation as a pillar of the community. But all that vanished in December when he was jailed for his part in a £250m VAT fraud. Jasper Jackson discovers how a 10-year investigation by HMRC led to his downfall. By Jasper Jackson – Mobile News March, 2012

Recommended reading material

These articles give an overview of the need of (indirect) tax risk management.

Our article is about how Internal Audit could perform a more pro-active advisory role with respect to risk management and more in specific to Indirect Tax risks. Many companies prioritize too low indirect taxation, such as VAT. The consequences of this neglect can sometimes be dramatic.

Erroneous VAT calculations can wipe out a company’s profit margin, or have consequences far beyond that. The problem can often be traced to operational weaknesses: less-than-adequate internal information systems that fail to properly process and display the VAT consequences of business transactions.

At a large multinational, a software error resulted in the company paying too much VAT over an 11-year period. In the case of another company, a software error resulted in the opposite situation: it had deducted € 40 million in excessive input VAT.

Many organisations lack an ‘indirect tax control framework’ for defining a strategy, systems and control mechanisms to manage risks linked to reporting VAT. With an indirect tax control framework, companies determine the management level that is responsible for the entire VAT reporting process, from beginning to end. The risk that VAT errors will compromise companies’ financial positions and reputations is a growing one. With globalisation of business, the complexity of transactions in terms of VAT is increasing.

Should this be part of Internal Audit annual audit plan to investigate?

One of the objectives of Internal Audit is via a risk based methodology to provide comprehensive assurance to the Board and senior management that companies’ material risks areas are managed efficiently and effectively.

In order to meet this objective from an indirect tax perspective what does Internal Audit need to realize these aims?

Starting point would normally be the company’s Indirect Tax Control Framework. For a first impression Internal Audit could raise the following questions:

Is the indirect tax strategy defined and aligned with companies’ business objectives?

Are material indirect tax risk areas defined?

Are roles and responsibilities for managing these risks explicitly assigned?

Are the internal controls that mitigate these risks explicitly documented?

Are the responsibilities for executing and monitoring the internal controls assigned

Are there regular meetings to discuss status of risks and internal controls and define actions?

Has a strategy been defined for managing the relationship with tax authorities? Have the responsibilities been assigned for the different geographic regions?

The answers give insight of the existence of the right building blocks of an Indirect Tax Control Framework and give an auditor the possibility to draft his first conclusion on process and risk management around indirect tax.

When however the conclusion is that the right building blocks TCF are not present (question are answered negatively), Internal Audit probably could take the role as pro-active advisor with regard to the right set up of internal indirect tax processes.

To perform such a role Internal Audit need to have the following competencies:

clear understanding of a normative framework from indirect tax perspective how and what need to be managed re these risks.

These are the conditions under which Internal Audit could fulfill a proactive role relating indirect tax risk management. In practice, the best way to achieve this is often to limit the scope and request the top 3-5 indirect tax risks that exceed the company’s indirect tax appetite. Often these risks can be benchmarked with other multinationals:

Intercompany transactions

Cross-border transactions

Correct deduction of input VAT (VAT paid)

An example of a normative process re cross-border transactions within the EU:

A normative framework faciltates Q&A during an Internal Audit exercise.

The actual situation (IST position) within the organization is then measured against this yardstick, generally resulting in a summary of the differences. Analysis of these gaps and the associated risks may lead to acceptance or to proposals for improvement. It is an efficient and effective approach that challenges the responsible process owners.

To what extend is internal audit able to fulfill an advisory role?

From Internal Audit by ASML – Accountant September 2013 by Lieuwe Koopmans some quotes (translated from Dutch to English by authors):

At ASML, one of the most important producers of semi-conductor systems, there is not only this ‘internal’ input but give internal auditors also actively their input on risks together with the business
My department Corporate Risk & Assurance can have an important advisory role on this topic. We can identify risks and indicate how to manage these. Also on a lower level in the organization, e.g at the implementation of a new IT-system, we can give our feedback and support.” (…) I believe that internal auditors can use their knowledge and skills besides audit, also can apply in the area of risk management. – Martin Reinecke

From an Indirect Tax Perspective, such a proactive advisory role hardly takes place. Other examples of major indirect tax risk areas relate to change:

Another example is Supply Chain transformations such as setting up of a Principal model. Internal Audit should in our view be part of the project team and should be actively involved and monitor during the design phase whether risks in the transformation will be appropriately managed. With a supportive normative framework, Internal Audit is able to raise critical questions and facilitate that indirect tax risks are prior to go-live identified and managed.

Do you see this work in practice?

Ferry Geertman is COO of the KEY Group and was Director IT Audit and Data Analytics at Deloitte Netherlands. From his background in Applied Mathematics, Ferry has vast experience in data analysis, including the design and evaluation of statistical samples as part of internal and external control. Ferry has extensive experience in advising about and evaluating of (IT)- risk management and internal control for multinationals.

Sven Hesselbach is partner at compliance-net GmbH and was a partner in charge of the Enterprise Risk Services Line at Deloitte in Frankfurt. Sven specializes in Corporate governance and compliance, internal audit, internal controls testing and documentation and to a great extent the IT part of these topics. Sven assists medium-sized and large companies in achieving their compliance and governance objectives.

Guido Czampiel is a partner at LiNKiT Consulting. Guido has more than 12 years of consulting experience focusing on large transformation projects within finance and IT. Guido has helped clients of different size and branches in successfully managing changes within their organization, processes and their systems.

In previous blogs I wrote about using data analysis to draw conclusions regarding the effectiveness of a Tax Control Framework (TCF) and how to establish a successful collaboration between TCF for VAT and data analysis.

But what is the role of the statistical sample in all this?

A statistical sample can be the starting point for developing a well functioning TCF for VAT. It can serve as a baseline measurement to examine the quality of the organization. Based on the identified errors the following can then be done:

– What is the maximal impact (€) of the identified errors?
– Do the identified errors indicate that the organization is failing to achieve its objectives? In other words, does the error exceed the risk or savings appetite of an organization?
– Are the errors incidental of structural? Additional data analyses can be executed to this end.

A prerequisite for all this is that it is predetermined what an error is. Compare this to the fail condition of a control that I explained in my previous blog.

The sample is then an efficient and effective starting point to either achieve or improve the indirect tax control framework.

In addition, the tax authorities in The Netherlands use the statistical sample as a means to monitor the effectiveness of TCF. If you have a TCF, performing a statistical sample based on the methodology used by the tax authorities offers advantages in the communication and work relation with the authorities.

Does the application of the statistical sample fit with achieving your objectives?

A Tax Control Framework for VAT focuses on managing material risk areas. An objective of the data analysis could include determination of the controls’ effectiveness and efficiency with regard to these risk areas.

In practice, I have noticed the following in reviewing data analysis regarding indirect tax:

The Tax Control Framework of the organization contains 10 controls that can be assessed by means of data analysis.

Of these controls, 3 were assessed using data analysis and 7 were not included in the assessment.

Out of the 12 tests that were executed, 7 contributed too little for drawing conclusions regarding either the effectiveness of Tax Control Framework or the quality of the VAT data.

The root cause lies in the fact that many data analysis applications are offered in standardized form in the market, which means that the data analysis is not fine-tuned for the organization respectively the industry.

In the above-described situation identical tests were executed for Accounts Payable and Accounts Receivable, even though the processes and risks differ significantly. Because identical tests were run for both AP and AR, this resulted in many false-positives. There was no tightening of the tests based on specific conditions of this organization whatsoever.

One of the control measures that was not included in the data analysis was determination of the reconciliation of the VAT return with the General Ledger and the Accounts Payable and Receivable reports.

This is remarkable since lack of reconciliation eliminates any proper ground for drawing conclusions. A commonly heard remark is “the current ERP systems always ensure reconciliation”. In practice, however, making the VAT return depends heavily on data extractions from the system and many operations in Excel – a manual and error-prone process.

In the normative framework of VAT processes and work instructions for composing the VAT reports and returns, it is indicated which data are to be used for the VAT return and whether additional actions are required. Data analysis enables determination as to whether this is actually carried out.

Process

VAT Risk

Control Activity

Test of Control

VAT Return

Compilation of VAT reports: reconciliation

VAT reports are inaccurate or incomplete

The VAT department has work instructions detailing the creation of the VAT reports. A checklist is available detailing all data required for completion of the VAT return. The VAT reports are reconciled to the General Ledger by the (VAT/Finance) department. Any differences are explained and followed-up.

Verify that work instructions for completion of VAT reports have been followed and signed off. Apply data analysis to assess reconciliation between VAT reports and GL

Execution of an effective data analysis requires objectives that are clearly defined in advance.

Examples of objectives are:

Contributions to the realization of fiscal objectives

Managing material risk areas concerning indirect tax

Realizing savings respectively optimizing the cash flow position

Compliance with laws and regulations (including financial statements)

Ascertaining that the organization has control over material VAT risk areas and that the TCF is working effectively.

Showing the tax authorities that the organization is in control, in order that a tax audit can be prevented.

Defining actions for improvement based on the observed inconsistencies.

‘process’ and ‘root cause’ analysis

more efficient and effective controls (manual and automated)

When the objectives are defined, the right approach regarding data analysis is as follows:

starting point is reconciliation of the VAT returns with the GL and AP and AR reports

gaining insight into specific VAT risk areas of the organization respectively the industry, such as:

intercompany transactions

cross-border transactions

transactions within fiscal unity

foreign VAT (included in incorrect VAT return)

clearly defining the applications of the data analysis on the basis of these objectives.

By Robbert Hoogeveen, CFO of the KEY Group

In Portugal it is required to submit a monthly SAF-T (PT) report for sales invoices from January 2013 onwards to the tax authorities.

The first SAF-T (PT) report has to be submitted before 25 February 2013. The data that has to be included in the SAF-T (PT) report are available in most ERP systems but creating a report with all the data in the correct data format is not easy.

Data has to be retrieved from different sources within the ERP system and has to be “enriched” to meet the required Portuguese format. In standard SAP a report function is available to create SAF-T reports for Portugal.

This report is based on the data archiving policy and functionality in SAP, it is however not designed for monthly reporting requirements. It is also very complicated to correctly configure this report and it will take significant resources and time to get the standard SAP report up and running in line with Portuguese tax authorities’ requirements. Because of the complexity of the standard SAP SAF-T reports, the KEY group has used another approach and developed a stand-alone solution. The blueprint of this stand-alone solution is as follows:

We define the data required from the different SAP resources (customer master, billing, accounting and tax data)

This data will be downloaded from SAP by using standard functionality

Together with the customer, the standard coding in use (i.e. invoice type) is defined and analysed on its impact on the SAF-T report

The downloaded data is imported in our data-analytics tool. The data from the different sources will be connected and processed in order to be able to get all mandatory data in the correct Portuguese format

The processed data will be exported to another KEY Group tool that creates the required output in the so-called XML format.

The solution described above is quite complicated but we have been able to automate the most important parts. The key challenge is the download of the required data from SAP but when we have received the data we can create the SAF-T report within 1 working day.

It is a flexible solution based on our extensive knowledge of ERP/SAP systems combined with our audit and data-analytics capabilities.

It is a tailor-made solution that could be implemented within a couple of days. In case you are facing similar issues in creating the monthly SAF-T reports for Portugal via SAP feel free to contact me.

Together we can create a fit-for-purpose solution that will be cost effective and allows you to comply with the Portuguese requirements.

This blog provides some background from a tax controversy perspective.

The OECD has issued in May 2005 a guidance note on the development of Standard Audit File –Tax (SAF-T) and recommends the use of SAF-T as a means of exporting accurate tax accounting data to tax authorities in such way that can it can be analyzed easily.

Portugal has now – as stated by Hoogeveen and Cornelisse earlier – implemented this guidance per January 1, 2013.

On monthly basis, companies are obliged to submit the SAF-T (PT) reports for sales invoices to the tax authorities. Besides the SAF-T (PT) requirement there is also a Portuguese requirement to implement a digital signature for all sales invoices.

From a risk management perspective mandatory data filing should give food for thought.

The submission of the SAF-T file means that a taxpayer has to provide specific data to the tax authorities every month.

From a tax controversy strategy it is common practice that before information is provided to the authorities, a company performs a risk assessment and determines the worst case scenario to avoid unforeseen tax risks. What if there are glitches in your data, input errors, empty fields, awkward descriptions in fields or apparent inconsistencies?

A checklist re submitting data to the tax authorities:

Have you analyzed the data and performed a tax risk assessment?

What are the tax authorities doing with this data: perform data analysis?

Does not meeting the requirement result in a higher risk of a tax audit?

What are the KPIs of the tax authorities?

If not impacting the present does the company show a audit trail that can be retroactively be investigated and backfire to tax position taken (ammunition for contra arguments, increase of penalties)

If the data provided does not meet the required data format could this result in a higher risk of a tax audit?

To avoid unforeseen risks or mitigate this risk is it not necessary to perform a data analysis prior to submitting data, as an internal pre-audit?

Data analysis as a pre-audit should be aimed at detecting and correcting inconsistencies and evaluating tax falls within the company’s risk appetite. More importantly, if similar data requests are becoming a common practice of the tax authorities, is it from a tax strategy perspective not important to set up a continuous monitoring process that on a real-time basis verifies and remediates data quality and data consistency?

Is the mandatory data request approach of the Portuguese tax authorities incidental or will this become a future trend?

Is it not likely in the downturn economy that more countries will follow this in order to maximize tax revenues?

What is the current status in the European Union or beyond?

In Austria it is also mandatory to provide data in electronic format. It looks like in France this will be introduced per January 2014.

In Luxembourg, Norway, Singapore and Canada providing data is still on a voluntary basis and only mandatory upon request by the tax inspector.

Consumption taxes

Consumption taxes include, on one hand general taxes on consumption, typically value added taxes (VAT and its equivalent in several jurisdictions the goods and services tax sales– GST) and retail sales taxes and on the other hand taxes on specific goods and services, consisting primarily of excise taxes, customs duties and certain special taxes.

Looking at the unweighted average of revenue from the five broad categories of taxes as a percentage of overall taxation in the OECD member countries, it can be seen that the proportion of consumption taxes is almost 31% (see Table 1.1).

In 2009, consumption taxes broke down to one-third for taxes on specific goods and services and two-thirds for general consumption taxes (see Tables 3.2, 3.4 and 3.7).

General consumption taxes

Retail sales taxes

A retail sales tax is a consumption tax charged only once at the last point of sale for products to the final end user.

The United States is the only OECD country within which a retail sales tax is employed as the principal consumption tax. However, the retail sales tax in the United States is not a federal tax.

Rather, it is a tax imposed at the state level. Currently, 46 of the 50 States impose retail sales taxes. In addition, over 7 500 local tax jurisdictions impose retail sales taxes in accordance with state law requirements.

To address inter-state and international taxation issues caused by the lack of harmonisation in state sales and use taxes, a number of states have entered into the Streamlined Sales and Use Tax Agreement (SSUTA available at http://www.streamlinedsalestax.org).

Value added tax

VAT is the most widespread general consumption tax in the world having been implemented by over 150 countries and in 33 of the 34 OECD member countries.

The value added tax system is based on tax collection in a staged process, with successive businesses entitled to deduct input tax on purchases and account for output tax on sales in such a way that the tax finally collected by tax authorities equals the VAT paid by the final consumer to the last vendor.

These characteristics ensure the neutrality of the tax, whatever the nature of the product, the structure of the distribution chain and the technical means used for its delivery.

When the destination principle, which is the international norm, is applied,

it allows the tax to retain its neutrality in cross-border trade. According to this principle, exports are exempt with refund of input taxes (“tax free”) and imports are taxed on the same basis and at the same rates as local production.

VAT is a neutral tax.

The concept of tax neutrality in VAT has a number of dimensions, including the absence of discrimination in a tax environment that is unbiased and impartial and the elimination of undue tax burdens and disproportionate or inappropriate compliance costs for businesses.

Neutrality is one of the principles that help to ensure the collection of the right amount of revenue by governments in the right jurisdiction.

In domestic trade, tax neutrality is achieved by the staged payment system: each (fully taxable) business pays VAT to its providers on its inputs and receives VAT from its customers on its outputs.

Input VAT incurred by each business is offset against output VAT so that the “right” amount of tax to be remitted to tax authorities by each business is the net amount or balance of those two. As a result of the staged payment system, VAT normally “flows through the business” to tax the supplies to the final consumer.

This ensures that the tax ultimately collected along a particular supply chain is proportional to the amount paid by the final consumer, whatever the nature of the supply, the structure of the distribution chain, the number of transactions or economic operators involved and the technical means used.

VAT is a consumption tax.

From an economic standpoint, VAT is a tax on final consumption by households.

Practically, the tax deduction mechanism ensures that the VAT paid by businesses along the value chain does not bear on them but, ultimately, on final consumers only.

Therefore, only people consume while businesses rather use inputs.

From a legal and practical standpoint, VAT is essentially a transaction tax, which aims at taxing the sale to the final consumer through a staged payment process across the supply chain.

VAT in cross-border trade.

The overarching purpose of the VAT as a levy on final household consumption coupled with its central design feature of a staged collection process lays the foundation for the core VAT principles bearing on international trade.

The application of the destination principle in VAT achieves neutrality in international trade.

Under the destination principle, exports are exempt with refund of input taxes (that is, free of VAT) and imports are taxed on the same basis and at the same rates as domestic supplies.

Accordingly, the total tax paid in relation to a supply is determined by the rules applicable in the jurisdiction of its consumption and therefore all revenue accrues to the jurisdiction where the supply to the final consumer occurs.

The application of the destination principle is more consistent with the main VAT principles and is accepted as the international norm.

Although most of the rules currently in force are consistent with the destination principle, their features are diverse across countries.

This can, in some instances, lead to double taxation or unintended non-taxation and create uncertainties for both business and tax administrations.

Implementation of the destination principle with respect to international trade in goods is relatively straightforward in theory and generally effective in practice, due in large part to the existence of border controls or fiscal frontiers.

Implementing the destination principle with respect to international trade in services and intangibles is more difficult.

Their nature is such that there are no customs controls that can confirm their exportation and their consequent right to be free of VAT or impose the VAT at importation.

Since it is not possible to physically follow the flow of services and intangibles across borders for tax purposes, the connection of the supply with a specific taxing jurisdiction must be done by reference to proxies.

The nature of those proxies and the way they are used may vary across jurisdictions as a result of local history and legal frameworks.

Consumption taxes on specific goods and services: Excise taxes

Excise taxes differ from VAT since they are levied on a limited range of products; are not normally liable to tax until the goods enter free circulation and are generally assessed by reference to the weight, volume, strength or quantity of the product, combined in some cases, with ad valorem taxes.

As with VAT, excise taxes aim to be neutral internationally since they are normally collected once, in the country of final consumption.

Chapter 2 – Consumption tax topics

Taxing international trade

The spread of VAT has been the most important development in taxation over the last half century. It now covers more than 150 countries and is recognised as the most efficient consumption tax both in terms of revenue for governments and neutrality towards international trade.

The challenges raised by globalisation have led governments to undertake common action to ensure a smooth interaction between VAT systems in the context of a global economy.

Governments began the process of establishing common guidelines for international VAT issues in 1998 at the OECD Ottawa Conference on electronic commerce, where Ministers welcomed the Ottawa Taxation Framework Conditions.

As a result, the OECD’s Committee on Fiscal Affairs (CFA) adopted the Guidelines on Consumption Taxation of Cross- Border Services and Intangible Property in the Context of E-commerce in 2001.

Further to the development of globalisation and cross-border trade, it became clear that many of the problems surrounding the application of VAT to e-commerce actually had their roots in the wider area of services and intangibles and that the remaining differences of approaches amongst jurisdictions still had potential for double taxation and unintended non-taxation.

The OECD therefore launched the OECD International VAT/GST Guidelines (the Guidelines) in 2006, which aim at providing guidance for governments on applying VAT more generally to cross-border trade.

It was agreed that the most pressing issue was the definition of the place of taxation for cross-border trade in services and intangibles and the conditions for the neutrality of the tax.

It was also agreed that the right to deduct input tax, an essential element in VAT systems that underpins the tax’s neutral character, should also be assured for cross-border trade. In January 2006, the CFA approved the two following basic rules:

The burden of value added taxes themselves should not lie on taxable businesses except where explicitly provided for in legislation;

for consumption tax purposes internationally traded services and intangibles should be taxed according to the rules of the jurisdiction of consumption.

These rules reflect the overarching purpose of a VAT to impose a broad-based tax on household consumption. According to the destination principle (see Chapter 1) the revenue of the tax should ultimately accrue to the jurisdiction where final consumption occurs.

In order to progress the work, the Guidelines are being developed in a staged process with a consultation process.

The objective is to arrive at a complete set of Guidelines applying to cross-border trade in services and intangibles by 2014.

Additional work is undertaken on improving the efficiency of the tax, the fight against VAT fraud and tax administration issues.

Cross-border VAT neutrality

In principle, the right to recover input VAT for businesses is exercised through the deduction mechanism in the staged payment process.

In a cross-border context, the export of goods and services is in principle free of VAT under the destination principle.

However, there will inevitably remain situations where businesses may incur a foreign VAT.

OECD countries have often implemented special mechanisms to avoid VAT being charged to the foreign taxpayer or to allow the foreign taxpayer to recover the input VAT incurred in the country.

The conditions and procedures for relief or recovery vary considerably between countries.

The lack of consistency in these procedures across countries and their current complexity may lead to significant compliance and administrative burdens for businesses and tax administrations.

The importance of the issue was confirmed by an OECD survey issued in 2010 “VAT/GST Relief for Foreign Businesses: The State of Play” (www.oecd.org/ctp/ct).

The CFA considered that the issue was significant enough to require remedies and undertook development of guidelines in this area.

As a result, the CFA approved International VAT Neutrality Guidelines in July 2011, after a successful public consultation. These Guidelines are one of the building blocks of the OECD International VAT/GST Guidelines.

The Commentary on the application of the International VAT Neutrality Guidelines in practice was approved for public consultation by the CFA in July 2012 and was published on the OECD website (www.oecd.org/ctp/ct) for public consultation (until 26 September 2012).

Definition of the place of taxation

According to the destination principle, the taxing rights on cross-border supplies of services and intangibles should accrue to the jurisdiction of consumption.

Although VAT primarily taxes household consumption, the multi-staged nature of the tax requires that each supply within the supply chain is subject to the rules of the relevant jurisdiction, including the intermediary supplies between businesses.

Thus, appropriate place of taxation rules should be applied at each stage of the supply chain. Over the last decade, OECD countries have amended their tax legislation to implement the destination principle.

However, there is a recognised need for a consistent set of approaches that maintain tax neutrality for business-to-business supplies and ensure the application of the destination principle for business-to-consumer supplies.

As part of the work on the OECD International VAT/GST Guidelines, a number of papers were issued for public consultation (www.oecd.org/ctp/ct).

The overall work on the Guidelines should be completed by end 2014. In addition anti-abuse provisions and mutual co-operation and dispute resolution procedures should also be developed.

Improving VAT efficiency

The current economic crisis has acted as a catalyst for structural reform in many OECD countries.

In the tax area such reforms aim at ensuring the long-term sustainability of public finances while safeguarding the competitiveness of the economy and its longer- term growth potential.

The pace and nature of reforms have varied markedly between countries but a consensus has emerged on the fact that growth-friendly tax reforms could help strengthen the jobs content of a recovery”.

This includes removing tax expenditures and shifting the tax burden towards tax bases that are less harmful to employment and growth, such as consumption taxes.

Against this background, the OECD organises its first Global Forum on VAT in Paris in November 2012 as a unique international platform for a truly global dialogue on VAT design and operation, for sharing policy analysis and experience, for identifying best practices and for strengthening international co-operation.

Tackling VAT fraud

There has been a significant and worrying trend in recent years for VAT to become a target for serious criminal activity.

Despite the measures taken by tax administrations and increased co-operation within the EU, criminal attacks against VAT systems have continued, spreading into new markets such as carbon emission allowances and energy supplies.

The development of appropriate legislation and practical tools are therefore critical to protect governments against international VAT fraud.

Chapter 3 – Value added tax: Yield, rates and structure

Limited to less than 10 countries in the late 1960s, VAT is today an essential source of revenue in more than 150 countries.

A number of factors have contributed to these developments i.e. globalisation, the systemic neutrality of the tax towards international trade and its efficiency for raising revenue.

It now accounts for approximately one fifth of the tax revenues of OECD governments and worldwide.

Key features of the VAT systems

Although most VAT systems build on the same core VAT principles, many differences exist in the way they are implemented in practice.

This is illustrated by the existence of a wide range of lower rates, exemptions and special arrangements that are frequently designed for non-tax policy objectives.

The rates of VAT

After a period of relative stability between 1996 and 2008, the average standard rate of VAT has started to rise again since 2008, suggesting that many countries have increased their VAT rates to consolidate their budgets.

With the exceptions of Chile and Japan, all OECD countries have one or more reduced rate generally applied to basic essentials such as medical and hospital care, food and water supplies and to activities that are considered socially desirable.

One of the reasons for the introduction of a differentiated rates structure is the promotion of tax equity or to stimulate consumption of “merit goods” (e.g. cultural products and education) and goods with positive externalities (e.g. energy-saving appliances).

The reasons for these reduced rates are likely to be rooted in a country’s socio-economic history, but their validity and their capacity to meet their objectives at an appropriate cost may be questionable.

Exemptions

In addition to reduced rates, there is also an extensive use of exemption across countries (see Table 3.11). Although it is a significant departure from the basic logic of VAT, all OECD countries (with the exceptions of New Zealand and Turkey) exempt a number of specific sectors considered as essential for social reasons, in particular health, education and charities.

In addition most countries also use exemptions for practical reasons (e.g. financial and insurance services, due to the difficulties in assessing the tax base) or for historical reasons (postal services, letting of immovable property, supply of land and buildings).

The exemption of items used as inputs into production removes the key feature of VAT, that of neutrality.

Exemption may introduce a cascading effect as the non-deductible tax on inputs is embedded in the subsequent selling price and is not recoverable by taxpayers further down the supply chain.

The importance of this cascading effect depends on where in the supply chain exemption occurs. If the exemption occurs immediately prior to the final sale, there is no cascading effect and the consequence is simply a loss of revenue since the value added at the final stage escapes tax.

On the other hand, if it takes place within the supply chain the distortions may be significant. For example, the exemption of financial services creates significant distortions with respect to both consumer and business decisions.

Thresholds

There is no consensus amongst OECD countries on the need for, or the level of, thresholds.

The main reasons for excluding “small” businesses are that the costs for the tax administration are disproportionate to the VAT revenues from their activity and, similarly, VAT compliance costs would be disproportionate for many small businesses.

The level of the threshold is often the result of a trade-off between minimising compliance and administration costs and the need to avoid jeopardising VAT revenue or distorting competition.

Restrictions to the right to deduct VAT on specific inputs

According to the VAT principles, the right to deduct input taxes should be limited to the extent that those inputs are used for the taxable purposes of businesses.

The right of deduction is legitimately denied where inputs are used to make onward transactions that fall outside the scope of the tax such as exempt transactions.

This is also the case for input tax relating to purchases that are not wholly used for furtherance of taxable business activity, for example, when they are used for the private needs of the business owner or its employees (i.e. final consumption).

Most OECD countries also have legislation in place that provides for input tax deduction blocking on a number of goods and services because of their nature rather than because of their use by businesses, generally with a view to ensure (input) taxation of their deemed final consumption e.g. restaurant meals, reception costs, hotel accommodation, use of cars by the employees of businesses, etc.

Chapter 4 – Measuring performance of VAT: The VAT revenue ratio

Given the diversity in the implementation of VAT between countries, it is reasonable to consider the influence of these features on the revenue performance of VAT systems.

One tool considered as an appropriate indicator of such a performance is the VAT Revenue Ratio (VRR), which is defined as the ratio between the actual VAT revenue collected and the revenue that would theoretically be raised if VAT was applied at the standard rate to all final consumption (Table 4.1).

In theory, the closer the VAT system of a country is to a “pure” VAT regime (i.e. where all consumption is taxed at a uniform rate), the more its VRR is close to 1.

On the other hand a low VRR can indicate a reduction of the tax base due to a large number of exemptions or reduced rates or a failure to collect all tax due (e.g. tax fraud).

The main methodological difficulty for calculating the VRR lies in the assessment of the potential tax base, since no standard assessment of the potential VAT base for all OECD countries is available.

In the absence of such data, the closest statistic for that base is final consumption expenditure as measured in the national accounts.

Few countries have a high VRR and most have a ratio below 0.65, which confirms the impact of the wide range of exemptions and reduced rates applied in OECD countries.

However, VRR figures should be interpreted with caution since they result from a combination of the policy efficiency (capacity to tax the full base at the standard rate) and compliance efficiency (the capacity of the tax administration to collect the tax due).

In addition, a number of factors such as the evolution of consumption patterns, incomplete application of the destination principle and the tax treatment of government activities may have a significant influence on the VRR in some countries.

Whilst the VRR is a useful tool for observing countries’ performance, more work is needed to identify the specific factors that influence the performance of VAT and how they interact.

Chapter 5 – Selected excise duties in OECD member countries

Excise duty, unlike VAT and general consumption taxes, is levied only on specifically defined goods. The three principal product groups that remain liable to excise duties in all OECD countries are alcoholic beverages, mineral oils and tobacco products.

While excise duties raise substantial revenue for governments, they are also used to influence customer behaviour with a view to reducing polluting emissions or consumption of products harmful for health such as tobacco and alcohol.

While the main characteristics and objectives ascribed to excise duties are approximately the same across OECD countries, their implementation, especially in respect to tax rates, sometimes gives rise to significant differences between countries (Tables 5.1 to 5.5).

For example, excise duties on wine (Table 5.2) may vary from zero to more than USD 2.5 a litre. Current excise rates for mineral oil products again illustrate the wide disparity.

For example, excise taxes on premium unleaded gasoline vary from USD 0.109 in the United States to USD 1.483 in Turkey for 1 litre.

A much more significant feature of excise duties on mineral oils is the fact that duty rates have been used to affect consumer behaviour to a greater degree than in other areas. Tobacco products are subject to excise taxes that most often rely on a combination of ad valorem and specific elements.

Chapter 6 – Taxing vehicles

Motoring has been an important source of tax revenue for a long time thanks to a wide range of taxes imposed on users of public roads.

Vehicle taxation in its widest definition represents a prime example of the use of the whole spectrum of consumption taxes.

These taxes include taxes on sale and registration of vehicles (Tables 6.1 and 6.3); periodic taxes payable in connection with the ownership or use of the vehicles (Table 6.2); taxes on fuel (Table 5.4) and other taxes and charges, such as insurance taxes, road tolls etc.

Increasingly, these taxes are adjusted to influence consumer behaviour in favour of the environment.

Table 5.3 illustrates, as an example, the wide differences in the level of taxes on sale and registration of motor vehicles. Indeed, the maximum tax for passenger cars may vary from less than 7% of the value of the car in Washington, DC, to 195% in Copenhagen.

Environment issues are increasingly taken into consideration for the design of vehicle taxation since it is increasingly considered as an efficient tool to influence customer behaviour and encourage the purchase of low polluting vehicles.

In 2012, more than two thirds of OECD countries apply rate differentiation according to environmental criteria.

A proposal for a Quick Reaction Mechanism (QRM), that would enable Member States to respond more swiftly and efficiently to VAT fraud, was adopted by the Commission today.

Under the QRM, a Member State faced with a serious case of sudden and massive VAT fraud would be able to implement certain emergency measures, in a way which they are currently not allowed to under VAT legislation.

In this context, the proposal provides that Member States would be able to apply, within the space of a month, a “reverse charge mechanism” which makes the recipient rather than the supplier of the goods or services liable for VAT.

This would significantly improve their chances of effectively tackling complex fraud schemes, such as carrousel fraud, and of reducing otherwise irreparable financial losses.

In order to deal with possible new forms of fraud in the future, it is also foreseen that other anti-fraud measures could be authorised and established under the QRM.

Algirdas Šemeta, Commissioner for Taxation, Customs and Anti-Fraud, said: “When it comes to VAT fraud, time is money. Fraudsters have become quicker and cleverer in developing schemes to rob the public purse. We must strive to be one step ahead of them. The Quick Reaction Mechanism will ensure that our system is sufficiently equipped to tackle VAT fraud effectively. It will help preserve much needed public revenues and create a fair and level-playing field for honest businesses.”

VAT fraud costs the EU and national budgets several billion euro every year. In some serious cases, vast sums are lost within a very short timeframe, due to the speed at which fraud schemes evolve nowadays. For example, between June 2008 and December 2009, an estimated €5 billion was lost as a result of VAT fraud in greenhouse gas emission allowances.

Currently, if a Member State wishes to counteract VAT fraud through measures not provided for under EU VAT legislation, it must formally request a derogation to do so.

The Commission then draws up a proposal to this effect and submits it to Council for unanimous adoption before the measures can be implemented.

This process can be slow and cumbersome, delaying the Member State in question from taking the necessary action to stop the fraud.

With the Quick Reaction Mechanism, Member States would no longer have to wait for this formal process to be completed before applying specific anti-fraud measures. Instead, a much faster procedure would grant them a temporary derogation within a month. The derogation would be valid for up to one year.

This would allow the Member State in question to begin counteracting the fraud nearly immediately, while more permanent measures are being established (and if necessary while the standard derogation procedure is being launched).

Background

The Quick Reaction Mechanism was foreseen in the new VAT Strategy (see IP/11/508), as well as the Communication on fighting tax fraud and evasion (seeIP/12/697), as a means of strengthening the fight against tax fraud in the EU and safeguarding public revenues.

How much is lost every year because of VAT fraud?

Although, due to the very nature of fraud, it is difficult to put a precise figure on VAT losses due to fraud, it is thought to be several billion euro each year. In a study on the EU VAT gap1, the Commission compared what Member States actually got in VAT receipts with what they could have expected.

While this VAT gap covers more than just fraud (also legal avoidance and insolvencies), the study set the gap at €106.7 billion in 2006 within the EU-25.

This represents an average of 12% of the net theoretical liability although several Member States were above 20%.

VAT fraud does not only affect the financial interests of the Member States and the EU.

It also has an impact on honest businesses which find themselves unable to compete on a level playing field in those sectors which are affected by a significant amount of VAT fraud.

What has the Commission done to address the problem of VAT fraud?

In 2006 the Commission presented a Communication to launch an in depth discussion at EU level on the need for a co-ordinated approach in the fight against fiscal fraud in the internal market. In 2008, the Commission set out a coordinated strategy to improve the fight against VAT fraud in the EU.

This Strategy included a series of targeted measures, including plans for legislative proposals (which have now all been put forward), and a longer-term reflection on how to fight the problem.

One key element was to see how administrative cooperation between tax administrations could be improved, and to establish a network of national officials to detect and combat new cases of cross-border VAT fraud.

This network – Eurofisc – is now operational and working to coordinate data exchange and establish an early warning mechanism against fraud.

What further measures to tackle VAT fraud does the Commission foresee?

In its Communication on the future of VAT, which it presented in December 2011 (IP/11/1508), the Commission set out priority actions needed to create a simpler, more efficient and more robust VAT system in the EU.

One of the overriding objectives for the new VAT system was to tackle VAT fraud more effectively, and a number of ideas were laid out on how to achieve this.

First, the Commission intends to monitor the full implementation of the abovementioned Anti-Fraud Strategy, making sure that all instruments in place against fraud are functioning to full potential.

It will examine ways to extend the automated access to information, and will assess whether anti-fraud mechanisms, such as Eurofisc, need to be strengthened. In 2014, it will report on whether further action is needed to strengthen or complement these measures.

In addition, the Commission will embark on a number of new anti-fraud projects.

The Quick Reaction Mechanism, proposed today, was one such initiative. In addition, the Commission launched the idea of setting up a EU cross border audit team composed of experts from national tax authorities to facilitate and improve multilateral controls.

As the success of any anti-fraud measure depends directly on the administrative capacity of the national tax authorities, the Commission will intensify its monitoring of the efficiency and effectiveness of the tax administrations of the Member States.

In the Commission’s Country Specific Recommendations for 2012, adopted by the Council in June, 10 Member States2 were told to improve tax compliance and collection. The Commission will also encourage the exchange of best practices in combating fraud in high risk sectors.

What is carousel fraud?

Carousel fraud is one of the most common types of large-scale VAT fraud schemes in the EU. Under EU legislation VAT on domestic sales is generally due by the seller while VAT on cross border sales is generally due by the purchasing companies.

In carousel fraud schemes, fraudsters import goods to a Member State VAT-free, and then charge VAT to the buyers. The sellers then disappear without paying the tax to the authorities, while the buyers deduct the VAT they paid from their overall taxable income, thus creating a loss to public finances.

It is called carousel fraud because there are usually a number of companies involved, each liable to VAT which goes unpaid, and the final buyer reclaims the VAT from the tax authorities before disappearing.

What is the “reverse charge mechanism”?

The reverse charge mechanism undermines the whole basis of carousel fraud, by switching the tax liability. Under this mechanism, the customer, rather than the supplier, is liable for VAT.

The customer (if a taxable person) must report and pay the VAT, and can deduct this VAT from their taxable income at the same time.

1 : DG Taxation and Customs Union, Report 21 September 2009, Study to quantify and analyse the VAT gap in the EU-25 Member States, Reckon LLP

Richard Cornelisse is CEO of the KEY Group and worked previously as Big4 Partner in the Tax Performance Advisory and Indirect Tax Practice and blogs on Tax Function Effectiveness and Tax Control Framework developments.

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The Governments of the Gulf Cooperation Council (GCC) – Bahrain, Kuwait, Oman, Qatar (status unknown due to GCC politics/friction), Saudi Arabia and the United Arab Emirates that make up GCC – are committed to form a common framework for the introduction of value added tax (VAT) in the region. In order to achieve conformity within … Continue reading Being re […]

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Tax Management Consultancy is designed to keep readers abreast of current developments, but it is a general guide only and is not intended to be a comprehensive statement of the law. No liability is accepted for the opinions it contains, or for any errors or omissions